Measuring and Explaining Changes in REIT Liquidity: Moving Beyond the Bid/Ask Spread

Abstract

This paper investigates changes in REIT liquidity since the REIT boom of 1993. In contrast to previous research that investigates liquidity via the bid/ask spread, we examine the impact of trades on REIT share price movements. In the first part of the paper, we use trade by trade data for REITs traded on the major U.S. exchanges to estimate and compare Kyle's (1985) measure of inverse liquidity for the 1993 and 1996 time periods. For our full sample of equity REITs, there is a significant increase in REIT liquidity in terms of the median price impact of trades. The increasing importance of the self-advised/self-managed organizational structure is found to be a major factor driving increased REIT liquidity. Our results imply a decline in the asymmetric information faced by market makers and, therefore a reduction in the adverse selection costs of trading. The second part of the paper seeks to explain the factors driving the shift in the information environment in which REITs trade. Our investigation of the changes in the size distribution and resulting price impacts of REIT trades over the 1993-1996 period yields evidence of increased importance of informed traders to REIT price dynamics. By itself, the presence of more informed traders should decrease REIT liquidity. Our findings of increased liquidity, however, indicate that the increase in adverse selection costs due to the presence of more informed traders is more than offset by the increase in market thickness as a result of an increase in the number of uninformed (liquidity) traders.